System and method for trading packaged collar options on an exchange

ABSTRACT

A method of creating and trading packaged standard option collars on an exchange is provided, as well as a trading facility for trading such packaged standard option collars. Collars are created by identifying an underlying asset, a first leg of a collar is determined by determining the desired strike price for the first leg and selecting a standard option contract traded on the exchange having a strike price closest to the desired strike price. The second leg is determined by selecting another standard option, the opposite of the first leg, having an option price substantially offsetting the option price of the first leg. Once the legs of the collar have been selected the collar package may be listed on the exchange, and orders for the collars may be processed by matching orders for opposite positions in the collar.

CROSS-REFERENCE TO RELATED APPLICATIONS

This application is a divisional of U.S. application Ser. No.11/122,511, filed May 4, 2005 now U.S. Pat. No. 7,562,046, the entiretyof which is incorporated herein by reference.

FIELD OF THE INVENTION

The present invention relates to a method of creating and tradingzero-cost, or near-zero-cost collars as packaged investment instrumentsas well as to trading facilities for trading such packaged collars.

BACKGROUND

Collars are a mechanism by which investors may manage the risk inherentin owning an underlying asset such as a stock. A collar comprises twolegs. The first is a long, out-of-the-money, put option, which is anoption to sell the underlying asset at a set price. The put option legprotects against declining prices. The second leg is a short,out-of-the-money, call option which gives the right to purchase theunderlying asset at a fixed price to another. The proceeds from the saleof the call option maybe used to finance the purchase of the put option,resulting in a zero-cost, or near-zero cost transaction.

In order to understand the risk managing characteristics of collars, abrief overview of options contracts and how they can be used to limitrisk is helpful. Options contracts are well known financial instruments.An option is a contract that grants the right, but not the obligation,to buy or sell an underlying asset at a specified price on or before acertain date. There are basically two types of options: call options andput options. A call option confers the right to purchase the underlyingasset at a specified price. A put option confers the right to sell theunderlying asset at a specified price. In both cases the specified priceis known as the “strike price.”

Options are contracts between investors. A first investor must purchasean option from second investor. The first investor having purchased theoption from the second investor is said to have taken a long positionrelative to the option and the second investor is said to have taken ashort position. The amount paid by the long investor to the shortinvestor is known as the option price. Whether or not the option isexercised (i.e. the option is invoked to either purchase or sell theunderlying asset) is solely in the discretion of the long investorholding the option. A call option becomes valuable, is “in-the-money,”if the market price of the underlying asset rises above the strikeprice. Otherwise, the option is “out-of-the-money” and has no value.When a long investor elects to exercise an in-the-money call option, thelong investor pays the strike price to the short investor and the shortinvestor delivers the underlying asset to the long investor. Converselya put option becomes valuable, is “in-the-money” when the market priceof the underlying asset falls below the strike price of the option.Otherwise, the option is “out-of-the-money” and has no value. When along investor elects to exercise an in-the-money put option, the shortinvestor must pay the strike price to the long investor and the longinvestor delivers the underlying asset to the short investor.

In many cases the parties may choose to forego delivery of theunderlying asset and settle the contract in cash. Cash settlement merelyrequires the short investor to pay the long investor the differencebetween the strike price and the prevailing market price of theunderlying asset. If the option expires out-of-the-money, the marketprice of the underlying remains below the strike price of a call optionor above the strike price of a put option, the short investor paysnothing to the long investor and retains the option price.

Options can be highly speculative investments. They can also be used astools for managing risk. Zero-cost or near-zero-cost collars are a lowcost mechanism that can be used to limit the risk that an asset willlose a significant amount of its value. In order to understand the riskmanagement potential of options collars it is helpful to review therisk-reward curves for various investments. FIG. 1 is a graph 100showing the risk-reward curve 102 for an investor who has investeddirectly in an asset. The asset may be, for example, a share of stock ina hypothetical company XYZ Corp. The horizontal axis of the graphrepresents the market price of the asset, and the vertical axisrepresents the investor's profits or losses from his or her investment.In this example, the investor purchased the asset at a market value of$50. The investor's profits or losses are tied directly to the marketprice of the asset. If the market price rises above $50 the investorsees a profit. If the market price falls below $50 the investor sustainsa loss. Profits or losses are linear, based solely on the market priceof the asset. From curve 102 it can be seen that the investor's maximumrisk is $50, the total amount of his or her investment. The potentialgain, however, is substantially unlimited.

FIG. 2 is a graph 110 showing the risk-reward curve 112 for an investorwho has taken a long position in a call option. The horizontal axisrepresents the market price of the underlying asset, e.g. a share of XYZCorp. The example shown has a strike price of $50 and an option price of$10. If the market price of the underlying asset remains below the $50strike price, the option remains worthless and the long investor riskslosing the $10 cost of the option. This condition is represented by thehorizontal portion 114 of the risk-reward curve 112. If the market priceof the underlying rises above the strike price however, the option isin-the-money and has value. This situation is represented by thepositive slope portion 116 of the risk-reward curve. The value of thein-the-money option is equal to the difference between the market valueof the underlying asset and the strike price. When this differenceexceeds the option price, $10, the long investor begins to see a profit.As is visually quite clear from the graph, the long investor's risk islimited to the option price, but the potential gain is essentiallyunbounded.

FIG. 3 is a graph 120 showing the risk-reward curve 122 for an investorwho has taken the opposite position from the investor of FIG. 2, namelya short position in a call option for XYZ Corp. The risk-reward curve122 is the inverse of curve 112 shown in FIG. 2. The risk-reward curve122 also comprises two distinct legs. The first leg 124 corresponds tothe option being out-of-the-money, the market price of the underlyingasset remaining below the strike price. Under these market conditionsthe option is worthless and the short investor retains the $10 optionprice paid by the long investor. Once the market price of the underlyingasset moves above the strike price, however, the option acquires valueand the short investor is obligated to pay the long investor an amountequal to the difference between the market price of the underlying assetand the strike price. If this amount exceeds the $10 options price theshort investor suffers a loss. The negative slope portion 126 of therisk-reward curve corresponds to the call option being-in-the-money. Asthe second leg 126 of the risk-reward curve 122 shows, the potentialloss to the short investor is substantially unlimited, whereas thepotential gain is limited to the received option price.

Next we turn to FIG. 4 which is a graph 130 showing a risk-reward-curve132 for an investor who has taken a long position in a put option. Inthis case the option again has a strike price of $50 and a $10 optionprice. Since a put option represents the right to sell the underlyingasset at the strike price, a put option is in-the-money when the marketprice of the underlying asset drops below the strike price. As with therisk-reward curves in FIGS. 2 and 3, curve 132 comprises two distinctlegs. The first negatively sloped leg 134 corresponds to the optionbeing in-the-money, the market price of the underlying asset below thestrike price of the put option. The second horizontal leg 136corresponds to the option being out-of-the-money, the value of theunderlying asset above the strike price of the put option. The maximumreturn on a put option is the strike price minus the option price. Thisassumes that the underlying asset has completely lost its value andbecome worthless. As long as the difference between the strike price andthe value of the underlying asset exceeds the option price, in this case$10, the long investor who purchased the put option realizes a profit.If the value of the underlying asset remains above the strike price, theput option is worthless and the long investor experiences a loss equalto the price of the option.

Finally, FIG. 5 shows a graph 140 of a risk-reward curve 142 for aninvestor who takes a short position in a put option. Again, therisk-reward curve comprises two distinct legs. The first leg 144 occurswhen the put option is in-the-money, the market price of the underlyingasset has moved below the strike price. The second leg 146 correspondsto the option being out-of-the-money. When the option isout-of-the-money the option is worthless and the short investor retainsthe option price, realizing a small profit. When the put option isin-the-money, however, the short investor is obligated to purchase theunderlying asset at the strike regardless of the prevailing marketprice. If the difference between the strike price and the prevailingmarket price of the underlying asset is greater than the option pricepaid for the option, the short investor experiences a loss. The maximumloss the short investor can sustain if the underlying asset loses all ofits value and becomes worthless is equal to the strike price minus theoption price.

Options may be employed to manage the risk of changes in the value of anunderlying asset. For example, referring back to FIG. 1, where aninvestor purchases a share of XYZ Corp. for $50. Holding this singleshare, the investor's maximum risk exposure is $50. If the company goesout of business and the stock becomes worthless the investor loses hisentire $50 investment. If, however, the investor purchases a put optionwith a strike price of, for example $40, the investor locks in the rightto sell the stock at $40 regardless of any further price declines. Theinvestor's maximum loss would be the cost of the put option $10 plus thedifference between the purchase price of the asset ($50) and the strikeprice of the put option ($40). In this case a total of $20. Theinvestor's maximum loss can be further limited by financing the $10purchase of a put option by a corresponding sale of a call option. Ifthe investor sells a call option for the same price as the put optiondescribed above, he has limited his downside risk at essentially “zerocost.” The transaction is zero-cost in the sense that the downside riskprotection did not require a cash outlay. In reality, however, thedownside risk protection was purchased at the expense of up-sidepotential. By selling a call option the investor is obligated to sellthe underlying asset (his share of XYZ Corp.) at the strike price of thecall option regardless of how high the price of the stock rises. Thus,the investor's upside potential is limited to the strike price of thecall option.

The arrangement just described is known as a zero cost collar. It iszero cost since the sale of the call option is used to offset the costof purchasing the put option. The arrangement places a “collar” on thevalue of the investor's investment, placing a finite limit on bothdownside losses and upside gains. FIG. 6 shows a graph 150 of arisk-reward-curve 152 of a zero costs collar as described. Therisk-reward curve 152 is essentially the sum of the risk-reward curve152 for the underlying asset (FIG. 1), the risk-reward curve 122 forshort call option (FIG. 3) and the risk-reward curve 130 for the longput option (FIG. 4). The risk-reward curve 152 comprises 3 segments. Thefirst 154 represents the investor's maximum loss if the price of theunderlying asset falls below the strike price of the long put option.The third segment 158 represents the investor's maximum gain if theprice of the underlying asset rises above the strike price of the shortcall option. The narrow band 156 in the middle represents the investor'srisk exposure to price fluctuations between the strike price of the putoption and the strike price of the call option. With the zero costcollar the investors' maximum losses and maximum gains are limited tothis narrow range 156.

Collars have been traded in the over-the-counter market. Investors mayassemble the various pieces using customized contracts to create variousoffsetting collar positions. Heretofore, collars have not been traded onexchanges. Trading such a product on an exchange is complicated by thefact that exchanges are limited to trading standard option contractshaving prescribed strike-price intervals. Using standard optioncontracts it is difficult to assemble a package of off-settingpositions. This complication is absent in the over-the-counter marketsince dealers are free to customize contracts as necessary. Suchcustomization, however, may limit the liquidity of the over the counterpackaged collar options.

SUMMARY

A method of creating and trading packaged standard options collars on anexchange is provided. In an embodiment the packaged standard optionscollars may include opposite positions in out-of-the-money call andout-of-the-money put option contracts based on the same underlyingasset. Thus, a first investor will take a short position in a standardcall option and a long position in a standard put option, while a secondinvestor taking the opposite side of the collar will take a longposition in the standard call option and a short position in thestandard put.

A first leg of the collar is selected having a strike price that isout-of-the-money by a desired amount. The second leg of the collar isthen selected based on the option price of the first leg. The second legis an option having an option price that substantially offsets theoption price of the first leg. A desired strike price may be calculatedbased on the previous day's closing price of the underlying asset, orthe desired strike price maybe calculated continuously in real-time.

Because the legs of the collar will be standard option contracts tradedon the exchange, it may not be possible to find a standard option havingthe exact strike price as that desired for the first leg. In this case,the standard option contract having a strike price nearest the desiredstrike price is selected. Similarly, when determining the second leg ofthe collar, there may not be a standard option having a price that willexactly offset the price of the first leg. Therefore, a standard optionhaving an option price that most nearly offsets the option price of thefirst leg is selected. For establishing the option price, the mid-pointbetween the current bid and current offer may be used.

According to one aspect of the invention, a method for creating andtrading packaged standard option collars begins with the step ofidentifying the underlying asset on which the collar will be based. Afirst leg of the collar, either a standard call option or a standard putoption, is selected based on the strike setting price of the underlyingasset and a “moneyness factor” which determines how far out-of-the-moneythe strike price of the first leg is to be. The next step is to selectthe second leg of the collar based on the option price of the first leg.The second leg is a standard option of the opposite type as the firstleg (a put option if the first leg is a call option, a call option ifthe first leg is a put option) having an option price that substantiallyoffsets the option price of the first leg. Once the two legs have beenselected, the strike prices of the two legs are published and the collarmay be listed on an exchange. Quotes may be disseminated to investors.Investors may place orders for collars, and the orders may be executedby matching orders for opposite positions. Executing a collar includesexecuting both legs of the collar. Post trade processing may includeseparate trading of the individual legs of the collar, or themaintenance of the legs as an separable package of options. The optionsthat make up the legs of the collar may be tagged for monitoringpurposes so that the exchange and or investors may track whethercontracts are or once were part of a packaged collar.

Other systems, methods, features and advantages of the invention willbe, or will become, apparent to one with skill in the art uponexamination of the following figures and detailed description. It isintended that all such additional systems, methods, features andadvantages be included within this description, be within the scope ofthe invention, and be protected by the appended claims.

BRIEF DESCRIPTION OF THE DRAWINGS

FIG. 1 is a graph showing potential returns from the direct purchase ofan asset.

FIG. 2 is a graph showing potential returns from the purchase of a calloption.

FIG. 3 is a graph showing potential returns from the sale of a calloption.

FIG. 4 is a graph showing potential returns from the purchase of a putoption.

FIG. 5 is graph showing potential returns from the sale of a put option.

FIG. 6 is a graph showing the potential returns from the purchase of anasset and an option collar comprising the sale of a call option on theasset and the purchase of a put option on the asset.

FIG. 7 is a flowchart describing a method for creating and tradingpackaged standard option collars on an exchange.

FIG. 8 is a listing of standard options based on the S&P500 index.

FIG. 9 is a listing of a package standard option collar according to thepresent invention.

FIG. 10 is a block diagram of an electronic trading facility for tradingpackaged standard option collars are published.

FIG. 11 is a block diagram of backend systems supporting tradingpackaged standard options contracts.

DETAILED DESCRIPTION OF THE PRESENTLY PREFERRED EMBODIMENTS

Methods of creating and trading zero-cost or near-zero cost optioncollars on an exchange, as well as a system for trading such packagedoptions on an electronic trading facility are set forth below. Anexchange based collar according to one embodiment pairs the sale of anout-of-the-money call option with the purchase of a similarly pricedout-of-the-money put option.

A method of creating and trading a zero cost, or near zero cost collarcomprising a package of standard exchange traded option contracts isdepicted in the flow-chart 200 shown in FIG. 7. In a first step S1, theexchange identifies an underlying asset for which a collar optionpackage is to be offered. The second step S2 is to determine a first legof the collar. This may involve selecting the most appropriate standardcall option or standard put option for the collar. The determination ofthe first leg of the collar will influence the determination of thesecond leg in step S3. If the first leg determined is a call option,then the second leg will be a put option, and vice-versa. The second legis selected so as to offset, as nearly as possible, the revenue from thefirst leg. Once the legs of the collar have been established, the strikeprices for both legs are published at step S4. Quotes for the packagedcollars are disseminated in step S5. Investor may place orders or placebids and offers for the packaged collars based on the published quotes.At step S6 collars are executed by matching investors taking oppositepositions for each of the legs of the collar. Finally, at step S7, posttrade processing is performed to account for the transactions comprisingthe executed collar.

Next we will consider the individual steps of the method 200 in greaterdetail. The first step S1, identifying the underlying asset, may be afairly arbitrary decision. The exchange on which the collars will betraded selects the underlying assets for which it will make collarpackages available. A fundamental factor in selecting an asset will bethe exchange's desire to list collar packages that will be of interestto traders and in which investors will want to take positions. This maycoincide with assets for which trading in standard options is alreadyheavy, or assets that are highly volatile, or some other factor or groupof factors that would indicate potential investor interest in packagedcollars based on the asset. The underlying asset may be a tangible assetsuch as a stock or an intangible asset such as an index, interest rate,or the like. Essentially packaged collars may be assembled around anyunderlying asset, index or other indicator for which standard optioncontracts are traded on the exchange.

Since a zero-cost or near-zero-cost collar constitutes the sale of anout-of-the-money call option and the purchase of an offsettingout-of-the-money put option, it is immaterial in step S2 whether thecall leg or the put leg is determined first. Once the underlying assethas been defined in step S1, determining the first and second legs ofthe collar essentially means determining the strike prices for thecorresponding call and put options. The strike price of the first leg ofthe collar is determined by multiplying a “strike setting price” of theunderlying asset by a “moneyness factor.” Determination of the strikesetting price will vary depending on how the collars are listed. Forexample, the collars may be established and the strike prices for thecall and put options may remain stable and valid for a predefined periodof time, such as an entire trading day. Alternatively, the strike pricesmay be continually recalculated and updated in real time to reflectprice changes in the underlying asset throughout the course of a tradingday. In the first case, in which the collar strike prices remains validthroughout an entire day, the strike setting price may be set equal tothe underlying asset's closing price the day before. If the strikeprices are to be calculated in real time, the strike setting price willbe set equal to the current market price of the underlying asset eachtime the strike prices are calculated.

In either case, whether the strike prices of the legs are establishedfor a finite period of time or calculated dynamically, the strike priceof the first leg is determined by multiplying the strike setting priceby the moneyness factor. The moneyness factor determines how farout-of-the-money the first leg of the collar will be. If the strikeprice of the call leg is being determined first, the moneyness factormay be calculated by adding 1.00 plus the desired percentageout-of-the-money of the call leg expressed as a decimal. For example, ifthe first leg is to be a 5% out-of-the-money call option the moneynessfactor would be equal to 1.00+0.05=1.05. If the strike price of the putleg is to be determined first, the moneyness factor is calculated inmuch the same way, except that the desired percentage out-of-the-money(again expressed as a decimal) is subtracted from 1.00 rather thanadded. Thus, if the first leg is to be a 3% out-of-the-money put option,the moneyness factor would be equal to 1.00−0.03=0.97.

On exchange traded collars the two legs of the collars must be confinedto standard option contracts that are traded on the exchange. When thestrike setting price is multiplied by the moneyness factor the resulttypically will not coincide with the strike price of a standard optioncontract. Accordingly, the first leg of the collar may be selected asthe standard option contract (call or put) having a strike price nearestthe desired strike price. Of course other rounding rules could also beused, such as always using the standard option contract having a strikeprice nearest and above, or nearest and below the desired strike price,and so forth.

Once the first leg of a collar has been determined, the second leg isdetermined by identifying a standard option contract of the oppositetype and based on the same underlying asset. The second leg is chosen tohave, as nearly as possible, the same option price as the first leg.Thus, for example, if the first leg is a call option with a strike priceof $105 and an option price of 2.7, the second leg will be the standardput contract for the same underlying asset whose option price is nearest2.7. Since an investor entering the packaged collar will be selling thecall leg and buying the put leg, the transaction will cost the investornothing if the option prices for the put and call are identical. If theoption prices for the first and second legs are slightly different, thecollar may have a small price associated with it, or the investor mayactually receive a small payment if the price of the call option exceedsthat of the put.

Once both legs of the collar have been determined, the exchange mustnotify its users of the collar and of the strike prices for each leg ofthe collar, as called for in step S4. The exchange may accomplish thisby publishing the information on a website, by publishing aninformational notice, notifying vendors, and/or any other communicationchannels.

In step S5 the exchange disseminates quotes for the collar packages ithas created. A number of alternatives are possible for this step. Forexample, the exchange may develop an algorithm that identifies the bestbid and best offer for each leg of a collar, and quote indicative collarbids and offers based on the component legs. For example, the bid for acollar could be based on the bid of the call leg and the offer of theput leg. The collar may be quoted in collar terms, i.e., as a debit orcredit, based on the amount paid or received from taking a position inthe collar package.

Alternatively, Market Makers may quote firm prices at which collars maybe executed. Market Maker quotes may be disseminated instead of or inaddition to exchange published indicative quotes. Both the exchange'sindicative quotes and the Market Maker firm quotes may be disseminatedover a proprietary network, such as the Chicago Board Options Exchange(CBOE) Futures Network (CFN) or the options price reporting authority(OPRA), or the like.

Customer orders for packaged collars are executed in step S6. In a firstalternative investors may place orders based on the exchange'sindicative quotes. A matching engine receives orders and executes bothlegs of the spread simultaneously at or better than the indicativequoted market prices. If an order for a collar turns out to benon-executable due to changes in the market, the order can be processedaccording to the order specifications. If an investor places an orderbased on a firm Market Maker quote, the Market Maker automatically takesthe opposite side of each leg of the collar. The exchange's matchingfacility executes the orders at or better than the quoted market prices.

Finally, the post trade processing of step S7 may take on any number offorms. These will depend mainly on how the exchange decides to handleexecuted collars. For example, because the collars created according toembodiment described comprise standard option contracts already tradedindividually on the exchange, once a collar is executed the individualcomponents can be treated individually and processed and tradedseparately. In one alternative, the legs may be reported individually asseparate puts and calls. A tag may be placed on the legs for trackingpurposes to indicate that they were once part of a collar. The tag maybe withheld from customers, or the tag may remain with the legs so thatit may be reported to customers that they were legs of a zero costcollar transaction.

An alternative is to create collars having inseparable legs. Althougheach leg comprises a standard option, the legs of an inseparable collarcan only be traded together. Inseparable legged collars would not simplybecome individual standard option contracts. Rather, open interests frominseparable leg collars will stand alone and not be merged with the openinterests in the call and put series underlying the collar. Suchinseparable legged collars may continue to be traded and quoted asstandalone products with unique trading symbols even though they may betraded with the standard options of the same underlying asset and in thesame crowd or with the same designated primary market maker as thestandard options.

Next we will apply the method of the present invention to create a nearzero cost collar based on the S&P500 index. The call leg of the collarwill be derived first employing a 5% moneyness factor. For ease ofdescription the strike prices will be valid for a period of time basedon the S&P500's previous day's close, rather than being calculateddynamically. For purposes of the example, we will assume a previousday's close of 1206.8.

FIG. 8 shows sample listings 300 of a plurality of standard exchangetraded option contracts based on the S&P500. Each series listingincludes the expiration month 302, the strike price 304, the tradingsymbol 306, the option price for the last executed call option 308, thecurrent best bid on a call option 310, the current best offer on a calloption 312, the option price for the last transacted put option 314, thecurrent best bid for a put option 316, and the current best offer for aput option 318.

The call leg of the collar is to be calculated first using a moneynessfactor of 5%. The strike price of the call leg is calculated bymultiplying the previous day's S&P500 close, 1206.8, by a value equal toone plus the moneyness factor expressed a decimal, or, in this case1.00+0.05=1.05. This results in a calculated desired strike price of1267.14. 1267.14 does not correspond to the strike price of any of thestandard S&P500 call options. The standard S&P500 call option having astrike price nearest the calculated desired strike price of 1267.14 isthe April 1260 SZP call option 324. The last transacted price 326 forthe April 1260 SZP call option was 1.5. The current bid 328 is 1.3 andthe current offer 330 is 1.8. Since this is the standard call optionhaving a strike price nearest the desired calculated strike price, thisseries 324 is selected for the first leg of the collar. The sale priceof a call option in this series will be somewhere between the current1.3 bid and 1.8 offer. For purposes of establishing a collar themid-point between the current bid 326 and current offer 328 may be usedto establish the price of the call option, although other methods ofdetermining the prices may also be used. For example the last transactedprice, the current bid, the current offer, or some other price may beused to establish the option price of the first leg of the collar. Inthis case, the mid-point between the current bid of 1.3 and the currentoffer 1.8 for the 1260 SZP call option is 1.55. This is the approximateprice an investor buying the collar could expect to receive from thesale of a 1260 S&P500 call option with an April expiration.

The estimated option price for the first leg of the collar is then usedto determine the second leg. The second leg is the opposite of the firstleg. In this case since the first leg determined was the call leg, sothe second leg will be a put. Specifically, the second leg will be astandard put option that has an option price that comes closest tooffsetting the 1.55 option price of the first leg. Thus, we wish toidentify a put option having a current bid and current offer whosemidpoint is closest to 1.55. Reviewing the bids 316 and offers 318 forS&P500 put options in FIG. 8, we see that only three series of S&P500put options have bids and offers that straddle the desired option priceof 1.55. These are the 1115 SPT put 332 which has a current bid of 1.05and current offer of 1.55; the 1120 SPT put 334 which has a current bidof 1.2 and current offer of 1.7; and the 1125 SPT put 336 that has acurrent bid of 1.4 and a current offer of 1.9. The mid-point between thebid and offer for the 1115 SPT put option is 1.30, 1.45 for the 1120 SPTput and 1.65 for the 1125 SPT put. In this case, the estimated price ofthe desired call 1.55 is directly between the mid-points of the bid andoffer prices for the 1120 SPT put and the 1125 SPT put. Thus eithercould be selected as an appropriate second leg of the present collar.However, since the last transacted price for the 1120 SPT put option,1.5, is much closer to the desired option price than the last pricetransacted for the 1125 SPT put option, which is 2.1, the 1120 SPT putoption 334 will be selected for second leg of the collar.

Now that the individual legs of the collar have been determined it isnecessary to quote prices for the package of options. Recall that theinvestor buying the collar will be both selling a call and buying a put.Since the prices used in determining the legs of the collar were themidpoints between the current bids and offers of the put and calloptions themselves, these same midpoint prices may be used to establisha price for the collar. In this case, the price the investor must payfor the put option is subtracted from the price the investor receivesfrom selling the call option. The mid-point between the current bid andcurrent offer for the call leg is 1.55. The mid-point between thecurrent bid and current offer for the call leg is 1.45. Thus, aninvestor “buying” or taking a long position in the collar can expect toreceive money on the transaction. Accordingly, a price of −0.10 may bequoted for the collar.

However, option prices are traditionally quoted in terms of bids andoffers. A bid is the maximum amount an investor is willing to pay to buya position, and an offer is the minimum an investor is willing to acceptto sell a position. Since the investor buying the position typicallywants to pay as little as possible and the investor selling the positionwants to receive as much as possible, the current best offer willtypically exceed the current best bid. The difference between the two isknown as the spread. With a collar, the investor who is “buying” thecollar, or taking a long position with respect to the collar, is bothselling a call option and buying a put option. The price the longinvestor must “pay” for the collar (he may actually receive moneydepending on the ultimate price of the legs) will be determined by howmuch another investor is willing to pay for the call option, and howmuch the other investor is willing to accept for the put option. Theseprices can be best determined by viewing the current bids and offers forthe legs individually.

In the present example, the best bid for a 1260 SZP call option is 1.3.An investor may be able to get a higher price than 1.3, but an order iscertain to clear at 1.3. Similarly, the best offer for an 1120 SPT putoption is 1.7. An investor may be able to get a lower price than 1.7,but an order to purchase an 1120 SPT put is sure to clear at 1.7.Accordingly, a collar is certain to be executable when the long investoroffers the call option for 1.3 and bids 1.7 for the put option. In otherwords, the investor will have to pay 0.4 to ensure the collar transacts.

On the opposite side of the transaction, the investor who is “selling”the collar, or taking the short position with respect to the collar, isboth buying the call option and selling the put. The amount the shortinvestor will “receive” for the collar (he may actually have to paymoney to take the short position depending on the ultimate price of theindividual legs) will be determined by how much another investor iswilling to sell the call option for and how much the other investor iswilling to pay for the put option. In the present example, the bestoffer for a 1260 SZP call option, the first leg of the collar, is 1.8.An investor may be able to buy a 1260 SZP call option at a price betterthan 1.8, but since this is a standing offer an order for 1.8 is certainto transact. The best bid for a 1120 SPT put option is 1.2. An investormay be able to get a higher price for selling a 1120 SPT put option, butsince this is a standing bid an order is certain to transact at 1.2.Accordingly, a collar is certain to be executable when the shortinvestor bids 1.8 for the call option and offers the put option for 1.2.In other words, the short investor will have to pay 0.6 to ensure thatthe collar transacts.

In the first scenario the investor seeking to “buy” the collar, or theinvestor taking a long position in the collar, must pay the investor“selling” the collar or taking the short position 0.4. In the secondscenario the investor selling the collar must pay the investor buyingthe collar 0.6. Clearly, an investor desiring to take the long positionin the collar would prefer the second scenario. Conversely, an investorseeking to take the short position would prefer to receive the 0.4 ofthe first pricing scenario. The difference between these two prices 0.4to −0.6 (from the perspective of the amount paid by the investor buyingthe collar) may be considered the spread between the best bid, 0.4, andthe best offer −0.6. An order to purchase a collar is certain totransact at 0.4, and an order to sell is certain to transact at −0.6.The actual market price for the collar will likely be between these twoextremes.

FIG. 9 shows a listing 400 of the 5% out-of-the-money S&P500 collar. Thelisting 400 shows the strike setting price of the underlying index 402,the call strike calculation 404, the strike prices of the standardoptions above and below the calculated call strike 406, 408, thestandard call option having a strike closest to the 5% out-of-the-moneystrike 410, and the put strike 412 based on zero or near zero costcriteria. The listing 400 further includes the listings for the legs ofthe collar, namely, the selected put option 413 and the selected calloption 414. The listing next highlights the most relevant bids andoffers for the component options, including the 5% out-of-the-money callbid 416, and the zero-cost put offer 418, the 5% out-of-the-money calloption offer 420 and the zero cost put option bid 422. From these,collar bid and offer quotes 424, 426 are derived. With the informationincluded in the listing 400 investors may determine whether or not theywish to take a position in the listed collar.

FIG. 10 shows an electronic trading system 500 which may be used forlisting and trading packaged collar options. The system 500 includescomponents operated by an exchange, as well as components operated byothers who access the exchange to execute trades. The components shownwithin the dashed lines are those operated by the exchange. Thoseoutside the dashed lines are operated by others, but nonetheless arenecessary for the operation of a functioning exchange. The exchangecomponents of the trading system 500 include an electronic tradingplatform 520, a member interface 508, a matching engine 510, and backendsystems 512. Backend systems not operated by the exchange but which areintegral to processing trades and settling contracts are the ClearingCorporation's systems 514, and Member Firms' backend systems 516.

Market Makers 504 may access the trading platform 520 directly throughthe member interface 508, and quote prices for packaged collar options.Non-member Customers 502, however, must access the exchange through aMember Firm. Customer orders are routed through Member Firm routingsystems 506. The Member Firms' routing systems 506 forward the orders tothe exchange via the member interface 508. The member interface 508manages all communications between the Member Firm routing systems andMarket Makers' personal input devices 504; determines whether orders maybe processed by the trading platform; and determines the appropriatematching engine for processing the orders. Although only a singlematching engine 510 is shown in FIG. 10, the trading platform 520 mayinclude multiple matching engines. Different exchange traded productsmay be allocated to different matching engines for efficient executionof trades. When the member interface 502 receives an order from a MemberFirm routing system 506, the member interface 508 determines the propermatching engine 510 for processing the order and forwards the order tothe appropriate matching engine. The matching engine 510 executes tradesby pairing corresponding marketable buy/sell orders. Non-marketableorders are placed in an electronic order book. If the market moves andthe unexecuted orders on the electronic order book become marketable,they are executed at that time.

Once orders are executed, the matching engine 510 sends details of theexecuted transactions to the exchange backend systems 512, to theClearing Corporation systems 514, and to the Member Firms' backendsystems 516. The matching engine also updates the order book to reflectchanges in the market based on the executed transactions. Orders thatpreviously were not marketable may become marketable due to changes inthe market. If so, the matching engine 510 executes these orders aswell.

The exchange backend systems 512 perform a number of differentfunctions. For example, contract definition and listing data originatewith the exchange backend systems 512. Pricing information for packagedcollar options is disseminated from the exchange backend systems tomarket data vendor 518. Customers 502, market makers 504, and others mayaccess the market data regarding packaged collar options via, forexample, proprietary networks, on-line services, and the like.

FIG. 11 shows the exchange backend systems 512 needed for tradingpackaged collar options in more detail. A collar options packagedefinition module 532 stores all relevant data concerning the packagedoptions collar to be traded on the trading platform 520, including theunderlying asset, the strike prices of the first and second legs, theexpiration date, collar symbol, etc. A pricing data accumulation anddissemination module 535 receives contract information from the packagedcollar options contract definition module 532 and transaction data fromthe matching engine 510. The pricing data accumulation and disseminationmodule 548 provides the market data regarding open bids and offers andrecent transactions to the market data vendors 518. The pricing dataaccumulation and dissemination module 548 also forwards transaction datato the Clearing Corporation. Finally, post trade processing module 536performs post trade processing according to the specifications of thecollar package. For example, the post trade processing module 536 maytrack the legs of the collars, ensuring that inseparable legged collarsremain together as a package, or simply accumulating statisticsregarding the popularity of a particular collar package, and so forth.Such information may be supplied back to the matching engine to ensurethat collar positions are always matched with collar positions, and thatthe individual legs are not traded separately. The backend systems 512may include one or more computer processors and communications devicescontaining programming code configured to carry out the above mentionedfunctions and steps.

While various embodiments of the invention have been described, it willbe apparent to those of ordinary skill in the art that many moreembodiments and implementations are possible within the scope of theinvention. Accordingly, the invention is not to be restricted except inlight of the attached claims and their equivalents.

The invention claimed is:
 1. A method trading collars on an optionsexchange, the method comprising: in a processor of an exchange system:identifying an underlying asset for which standard options contracts aretraded on the exchange at an electronic trading system; identifying oneof an out-of-the-money standard call option or an out-of-the-moneystandard put option at the electronic trading system, the one of theout-of-the-money standard call option or the out-of-the-money standardput option having a first option price, wherein the out-of-the moneystandard call option and the out-of-the-money standard put option arebased on the identified underlying asset; identifying the other of theout-of-the-money standard call option or the out-of-the-money standardput option at the electronic trading system, the other of theout-of-the-money standard call option or the out-of-the-money standardput option having a second option price which substantially offsets saidfirst option price; listing, via a pricing data accumulation anddissemination module of the electronic trading system, theout-of-the-money standard call option and the out-of-the-money standardput option together as a package on the exchange; and wherein both theout-of-the-money standard call option and the out-of-the-money standardput option are placed in a single order for the package.
 2. The methodof claim 1 wherein a first position in the package is received at theelectronic trading system for a short position in the out-of-the-moneystandard call option and a long position in the out-of-the-money putoption.
 3. The method of claim 2 wherein a second position for thepackage is received at the electronic trading system for both a longposition in the out-of-the-money call option and a short position in theout-of-the-money put option.
 4. The method of claim 2 wherein a secondposition for the package is received at the electronic trading systemfor a long position in the out-of-the-money call option and a thirdposition is received at the electronic trading system for a shortposition in the out-of-the-money call option.
 5. The method of claim 1wherein the electronic trading system is configured to permit trading ofthe out-of-the-money standard call option and the out-of-the-moneystandard put option comprising the listed package as separate standardoptions after receiving the first position in the package.
 6. The methodof claim 1 wherein the electronic trading system is configured to onlypermit the out-of-the-money standard call option and theout-of-the-money standard put option to be traded together as thepackage.
 7. The method of claim 1 wherein the step of identifying one ofan out-of-the-money standard call option or the out-of-the-moneystandard put option comprises the electronic trading system identifyinga desired first leg strike price, wherein the desired first leg strikeprice is a desired percentage value above or below the market price ofthe underlying asset, and the identified one of the out-of-the-moneystandard call option or the out-of-the-money standard put option is astandard call option or a standard put option having a strike pricenearest the desired first leg strike price.
 8. The method of claim 1wherein the first option price is defined as a midpoint between a bestbid and best offer for the identified one of an out-of-the-moneystandard call option or the out-of-the-money standard put option, andthe second option price is a midpoint between a best bid and best offerfor the other of the out-of-the-money standard call option or theout-of-the-money standard put option.
 9. The method of claim 1 furthercomprising the step of publishing bids and offers for the package ofoptions, bids comprising a price investors are willing to pay to takeboth a short position in the identified out-of-the-money call option anda long position in the identified out-of-the-money put option, andoffers comprise a price investors are willing to pay to take both a longposition in the identified call option and a short position in theidentified put option.